Query No. 29

Subject:         

   Estimation of liability for outstanding claims.1

A.        Facts  of  the  Case

1. A public sector company offers various general insurance products such as, Fire, Marine, Transit, Motor, Personal Accident, etc.  One of the policies underwritten by the company is Motor Third Party Insurance under which legal liability suffered by the insured on account of injuries/death, caused to the public as well as property damage suffered by the public resulting from collision with the insured’s vehicle, is indemnified by the company.

2. The querist has stated that as the accounts of the company are prepared on mercantile basis, the losses reported but not settled at the year end are provided for.  Generally, the outstanding losses in the case of policies other than Motor Third Party are provided for on the basis of survey reports given by surveyors quantifying the loss.  These estimates are by and large realistic and can be easily verified by the auditors.   However, Motor Third Party losses are broadly divided into four categories, viz., death, grievous injury, minor injury and third party property damage.  The liability is estimated on the basis of certain criteria, such as, age of the person, number of dependent family members, income of the person, etc. The querist has further informed that the compensation awarded by the Motor Accident Claims Tribunals (MACT) varies from tribunal to tribunal as the compensation is not fully structured under the Motor Vehicles Act and certain element of subjectivity is involved in the awards pronounced by the judges.

3. The querist has further stated that till the year 2000-01, the company was providing for outstanding Motor Third Party claims based on the above factors.   However,  the  company observed, at  the  time  of finalisation  of accounts for the year 2001-02, that these claims have not been adequately provided for in the light of actual awards given by the MACT during the year 2001-02. Hence, the company conducted an exercise to arrive at the average amount paid per Third Party claim by each region during the year 2001-02 and compared the same with the average amount provided for outstanding claims by their Operating Offices as on 31.3.2002.  This study established the fact that the claims were underprovided since average amount provided per claim by their Operating Offices was considerably short of the average amount paid per claim by the regions.  Accordingly, the company provided an additional  amount of Rs.  308 crore at Head  Office on account  of its Operating Offices before finalising their accounts for the year 2001-02.

4.The querist has informed that the change in the method of estimating the liability from ‘case to case method’ to the ‘trends in settlement method’ was referred to two firms of chartered accountants for their opinion and advice. They have concurred with the action and opined that there is nothing wrong in estimating the liability on the basis of ‘trends in settlement method’ which reflected a more realistic picture of the liability.  The querist has also stated that the matter was referred to the appointed actuary who also agreed with the change and certified the additional liability provided at the Head Office.  The querist has provided the opinions of the firms mentioned above and the certificate of the actuary for the reference of the Expert Advisory Committee.

B . Query

5.The querist has sought the opinion of the Expert Advisory Committee as to whether the action of changing the method of estimation of outstanding liabilities from ‘case to case method’ to ‘trends in settlement method’ in case of Motor Third Party claims is justified and would not be construed as ad hoc.

C.  Points  considered  by  the  Committee

6.  The Committee notes that primarily the issue raised by the querist relates to whether provision for Motor Third Party claims would be adequate based on the ‘trends in settlement method’ as compared to the ‘case to case method’.

7. The Committee is of the view that the amount to be recognised as provision should be the best estimate of the expenditure required to settle the claims.  The best estimate of the expenditure required to settle the claims is the amount that an enterprise would rationally pay to settle the claims.  The estimates of outcome are determined by the judgement of the management of the enterprise, supplemented by experience of similar transactions and if appropriate, reports from independent experts, such as, actuaries.  In this regard, the evidence considered includes any additional evidence provided by events after the balance sheet date. Uncertainties surrounding the amount to be recognised as a provision are dealt with by various means according to the circumstances. For this purpose, various methodologies including models which consider relevant variables can be adopted to arrive at the amount based on the best estimate of the expenditure in respect of the provision.

8. In the present case also, the Committee is of the view that it is for the management to determine as to which method provides best estimate of the expenditure in respect of the provision for the Motor Third Party claims.  In this  regard,  in  general,  the  ‘case  to  case  method’  may  provide  the  best estimate since under such a method peculiarities and circumstances of the individual case would be considered.  This method does not rule out the use of  the  past experience related  to amounts  settled  in similar  cases  in the respective offices. The querist has, however, not provided this information as to whether in the ‘case to case method’ earlier followed by the company, the past experience related to settlement of claims was taken into consideration or it was based only on the judgement of the officials concerned. Thus, in the respective offices, while making an estimate under ‘case to case method’ historical data in respect of similar claims, i.e., trends in settlement of claims, can be used for estimating the amount of provision.   In other words, the ‘trends in settlement method’ can be considered even in respect of individual cases.   Conceptually, such a method is likely to provide better estimates compared to the method involving consideration of over-all averages based on regional experience, which does not distinguish between the four types of claims, namely, death, grievous injury, minor injury and third party property damage, as the company seems to be presently doing as per the ‘trends in settlement method’.  In any case, it is for the management to decide and the auditor to comment upon as to which of the methods provides the best estimate of the expenditure involved on settlement of claims.

D.  Opinion

9. On the basis of the above, the Committee is of the opinion, in respect of the issue raised in paragraph 5 above, that it is for the management to decide and for the auditor to comment upon whether the ‘trends in settlement method’ provides the best estimate of the expenditure required to settle the claims. In general, the ‘case to case method’ which also, takes into consideration the trends in settlement in similar circumstances, is likely to provide a better estimate compared to an over-all region-wise averaging under the ‘trends in settlement method’.

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 1  Opinion finalised by the Committee on 30.1.2003.